How to find quality at a reasonable price |
Tweet | ![]() |
<p><strong>Lex Hall</strong>: Hi, I'm Lex Hall and welcome to another edition of Morningstar's "Ask the Expert." Today, I'm joined by Ned Bell from Bell Asset Management. We're going to be talking about quality at a reasonable price, what that means and how investors can take advantage of it.</p>
<p>G’day, Ned.</p>
<p><strong>Ned Bell</strong>: G’day, Lex. Thanks for having me.</p>
<p><strong>Hall</strong>: Nice to see you again. Now, talking about QARP or quality at a reasonable price, I wanted to begin with a quote by Warren Buffett who in 1989 said, "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price." Is that we're sort of talking about when we talk about QARP?</p>
<p><strong>Bell</strong>: Yeah, I think it is and it's really – it's generating this distinction between the valuation risk that comes with quality investing and growth investing but also the earnings risk that comes with some of the growth investing we're seeing now. So, where we are now is, we're at a point where growth stocks have performed extremely well. But they're now the most expensive they've ever been. And value stocks have obviously lagged considerably. They've had a little bounce in September or October, but the earnings risk is very much so still in the value cap. And I think it's pertinent because we're moving into 2020 where the risk environment is picking up somewhat. The macro backdrop has a habit of accentuating the valuation risk and the fundamental risk in the value cohort.</p>
<p><strong>Hall</strong>: And so, what distinguishes a company – if I can put it that way – that you would consider fits the QARP criteria?</p>
<p><strong>Bell</strong>: Yeah, it's a good question. So, first of all, they have to get over a quality hurdle. That's the first point. So, when we think about quality, we're thinking about companies that have got great management teams, strong franchises, consistently high levels of profitability, strong balance sheets and good business drivers. So, they need to get over those hurdles first before they're even considered for QARP. And then, at that point, you need to think about what you're willing to pay for it. So, typically, we tend to look at companies that are generating it, for example, return on capital in excess of 10 per cent, 15 per cent as a starting point, but then you don't want to be paying over the odds for those companies. So, you want to be typically paying less than, say, 25 times earnings for those types of companies. So, it's that balance between quality and value that's really important.</p>
<p><strong>Hall</strong>: So, for a retail investor, what sort of tips would you give them if they were applying this strategy? What should they be looking out for in particular?</p>
<p><strong>Bell</strong>: Yeah. So, really, the only way to implement this type of strategy is via active management. I mean, there really is no ETF or passive implementation of this because the passive and ETF are products you can find out there that are either – they're either value or the growth or the quality that you simply don't find them where there's a combination of those factors applied at a stock specific level. So, what I would say is that investors should look for active managers that apply this type of philosophy, that have got a balance within their portfolio between high levels of profitability and sensible levels of valuation and make sure that those attributes have been consistent through a long period of time.</p>
<p><strong>Hall</strong>: What about – let's just pick a stock out of the air, say, Tesla, for example. Is that a tricky one? Is that deceptive?</p>
<p><strong>Bell</strong>: There's a few issues with Tesla.</p>
<p><strong>Hall</strong>: Yeah.</p>
<p><strong>Bell</strong>: Yeah. So, the first one, from a quality perspective, profitability is not generally synonymous with Tesla. So, it doesn't pass our quality test, for example. So, again, it doesn't make that 15 per cent return on capital threshold. And because it's not generating much profit, it's very difficult to value that company on an earnings level, because the earnings are always still to come, still to come, still to come. And then, the other issue I suppose with Tesla is because that's a very capital-intensive business, they're always rolling out new models, which means the profitability is always two years away.</p>
<p><strong>Hall</strong>: Yeah. Seems like there's a few companies here in Australia that fit that bill, like, you think of some of the buy now pay later companies, they're not profitable, they won't be profitable until 2021. So, that's certainly something to keep in mind, isn't it?</p>
<p><strong>Bell</strong>: Yeah, I think some of those things are probably more in that – they're good example of stocks in that growth cohort, where there's a lot of momentum, money chasing them, valuations are just not even really considered. And as much as the performance of them have been phenomenal. There always comes a time when the market tends to bring those stocks back to back to worth a bit. And we saw that in Q4 last year. And that was really the first test of the risk that we saw in value stocks and growth stocks, because to some degree, there was underperformance at both ends of the spectrum. So, a lot of those really well owned growth stocks underperformed because they were too expensive, and some of the value names underperformed because the macro was deteriorating.</p>
<p><strong>Hall</strong>: Let's finish on a few names that you think fit the QARP strategy.</p>
<p><strong>Bell</strong>: Sure.</p>
<p><strong>Hall</strong>: One that you've highlighted is Booking.com.</p>
<p><strong>Bell</strong>: Yeah. So, Booking.com is a stock we've owned for a number of years. So, they are a leader in the online travel business. Most importantly, it's a really high return on capital, asset light business. They generate 25 per cent plus return on capital. The stock trades on a P/E of about 17 times earnings and it's growing its earnings at 10 per cent plus going forward. So, the combination of those three things is really, really powerful because it means that we can make money through the P/E rerating, plus earnings compounding and that's really the Holy Trinity is to get the combination of those two.</p>
<p><strong>Hall</strong>: OK. Another one on the list is Home Depot.</p>
<p><strong>Bell</strong>: Yeah. So, Home Depot is one of the few brilliant U.S. retailers in what's been a very turbulent period for retail in the U.S. But Home Depot, Costco, maybe one or two others have been the real leaders. They've led that category for a number of years. I think, really interestingly, the reality is that the U.S. consumer is unbelievably strong right now. And so, as a play on the U.S. consumer in the tight labor market, I think Home Depot is a great way of playing that. And again, it's not that expensive. It's only trading at 20 times earnings. Again, 20 per cent plus return on capital, will grow its earnings at least 10 per cent going forward.</p>
<p><strong>Hall</strong>: Great. And finally, Broadridge Financial.</p>
<p><strong>Bell</strong>: Yes. Broadridge Financial is an interesting small/mid-cap name. It's a financial name, but what they do is, they do a lot of the back-office work and almost like the plumbing, if you like, for some of the big banks. So, the back-office work that they don't want to be doing, they will outsource to companies like Broadridge. So, in effect, what tends to happen is, when the banks come under a bit more pressure, when things are a bit more volatile, they're looking for cost savings, outsourcing some of their back-office work to Broadridge is a logical way of saving money. So, to some degree, there's a countercyclical element to the earnings drivers for Broadridge.</p>
<p><strong>Hall</strong>: Sounds as though they might have some work in Australia.</p>
<p><strong>Bell</strong>: They might. They might do a little bit of work (with Austrac maybe).</p>
<p><strong>Hall</strong>: Thanks for your insights.</p>
<p><strong>Bell</strong>: Great. Thanks Lex. Appreciate it.</p>
<p><strong>Hall</strong>: I'm Lex Hall for Morningstar. Thanks for watching.</p>

25/02/2021 The biggest takeaway from that period is not to panic when the market tumbles.

23/02/2021 From ETFs backed by bullion to miners with more upside potential - here's how to get yourself some gold.

23/02/2021 If the US is to stage a recovery by mid-year, it will need the consumer services sector to fire, says Morningstar's head of economic research Preston Caldwell.

19/02/2021 Morningstar's Brian Han weighs up News Corp's deal with Google and examines the effect of Facebook's decision to block content from Australian media outlets.

18/02/2021 Quay Global Investors' Chris Bedingfield explains how self-storage, data centres and industrial property can offer diversification and growth.

16/02/2021 Uniti Group and Nextdc are among the companies that SG Hiscock's Hamish Tadgell says have flourished during the pandemic.

15/02/2021 Hamish Tadgell of SG Hiscock explains the portfolio changes he’s made in a bid to capitalise on the shift.

10/02/2021 Which pandemic-related trends have already passed, and which ones might be around the corner?

05/02/2021 The battle between the Reddit army and hedge funds is nothing new—the question is will regulators be willing to step in, says Morningstar's John Rekenthaler.

03/02/2021 Competition is fierce for fast fashion retailers such as Asos, H&M, Zalando and Inditex. Morningstar analyst Jelena Sokolova takes a look at the sector.

01/02/2021 Volatility can be around any corner, says Morningstar director of personal finance Christine Benz.

28/01/2021 Retirees require stocks' growth potential, but they need a cash and bond buffer, too.

27/01/2021 Rebecca Jiang, manager of the JPMorgan China Growth & Income Trust, looks at why Chinese stocks soared in 2020 and whether the trend can continue.

25/01/2021 Redpoint's chief executive and portfolio manager Max Cappetta tells Lex Hall why he's got his eye on JB Hi-Fi, Goodman and Reliance Worldwide in 2021.

21/01/2021 Redpoint CEO and portfolio manager Max Cappetta looks at the dividend potential of large-cap names, the resilience of Qantas, and the local tech landscape.

19/01/2021 Stocks still look cheap across all subsectors, especially oilfield services and refining, says Morningstar analyst Dave Meats.

19/01/2021 What are the rewards and risks of using this technology?

15/01/2021 Morningstar's head of policy research Aron Szapiro explains what sort of changes a Biden government will make and how they will affect company valuations.

14/01/2021 Freight-rail, building temperature efficiency, and carmaking are among the sectors Aviva Investors' Jaime Ramos Martin has his eye on.

13/01/2021 Dividend investors had a hard time in 2020, but Morningstar analyst Dan Lefkovitz think the outlook is brighter for the year ahead.

11/01/2021 Morningstar Investment Management's Dan Kemp reveals the three investment themes on his mind for the year ahead.

06/01/2021 Morningstar equity analyst Allen Good looks at the prospects for oil and gas giants in the year ahead.

05/01/2021 China had a strong year after a rocky start, but can it continue—and what does a US President Biden mean for the region? Morningstar analyst Lorraine Tan explains.

04/01/2021 Morningstar equity director Alex Morozov considers the outlook for tech, travel and beyond for the year ahead.

01/01/2021 How to plan for things you can't plan.

25/12/2020 2020: we look back at the highs and lows of an unprecedented year in financial markets and explore the themes shaping 2021.

22/12/2020 Music streaming companies have seen stellar growth in user numbers. We ask Morningstar equity analyst Neil Macker if the trend can continue.

21/12/2020 While it stands as the largest addition in the index's history, this likely won't impact everyday investors all that much.

18/12/2020 Will there be opportunities to deploy cash in the new year? Will there be a reprieve from covid? And what will the incoming Biden administration mean for markets?

18/12/2020 Companies that specialise in solar, building efficiency and renewables underpin Aviva Investors' Climate Transition Global Equity Fund, says Jaime Ramos Martin.

16/12/2020 Why does liquidity matter to investors, and how can it affect your returns? Morningstar equities director Tom Whitelaw explains.

14/12/2020 Learn what we look for when rating a company.

14/12/2020 Morningstar's new approach unpacks the environmental, social and governance risks that companies face.

10/12/2020 Industrial companies typically generate better cash flows and can offer a steady income stream, says the IML founder.

09/12/2020 The lofty valuations of Tesla and Afterpay typify the effervescence and speculation in the market, says the IML founder.

08/12/2020 Car makers may not be an obvious investment choice for ESG-conscious investors, but Morningstar analyst Tancrede Fulop says some of the largest companies score highly in some measures such as safety and human capital.

07/12/2020 Janus Henderson's Matt Peron considers how the relationship between the US and China will evolve under a President Biden.

04/12/2020 What is active investing, and what is passive investing? We're at the whiteboard to explain the pros and cons of each

04/12/2020 Treasury Wine Estates remains an undervalued stock in spite of China's demand-destroying tariff on Australian wine. Morningstar director of equity research Adam Fleck explains why.

03/12/2020 And do any other assets currently compare?

02/12/2020 We're at an inflection point in ESG investing, says Sustainalytics founder Michael Jantzi. Here's why.

01/12/2020 Beaten-down travel stocks and BNPL providers featured heavily, says nabtrade’s Gemma Dale.

30/11/2020 Many people were waiting for the opportunity to buy shares at historic discounts, says nabtrade’s Gemma Dale.

27/11/2020 The 171-year-old wealth manager has had its scandals but there's merit to its turnaround strategy and the quality of its other assets, says Morningstar's Shaun Ler.

27/11/2020 BNPL products such as Zip Co help boost consumer spending but they come with risks and are overvalued, says Morningstar analyst Shaun Ler.

26/11/2020 The Magellan co-founder argues the ecommerce acceleration is here to stay and ponders the effect it will have on other sectors such as travel and commercial real estate.

25/11/2020 Greg Dean of Cambridge Global Asset Management explains why the consumer services sector has yielded healthy returns.

25/11/2020 Magellan's co-founder explains which tech behemoth the Magellan Global Fund no longer owns, why one was too tricky to value, and why regulation is no threat.

24/11/2020 Magellan's co-founder on why 2020 resembles 2000 and why covid-19 is a dry run for something that could be much worse without proper planning.

23/11/2020 Their shares have gotten hammered this year. Are they opportunities or value traps?

20/11/2020 Our new rating highlights the degree to which a fund or asset manager considers environmental, social, and governance issues.

19/11/2020 Morningstar's Grant Kennaway explains why sustainable funds are increasingly popular and why they're performing well.

17/11/2020 Morningstar director of equity research Johannes Faul looks at home improvement retailer Bunnings.

16/11/2020 From climate change to workers' rights, ESG is a big part of the investing world. We're at the Morningstar whiteboard board to explain what it means and why it matters.

12/11/2020 We're not out of the woods yet, says our head of equity research, as he looks for safety in businesses we can't live without and shies away from the banks.

11/11/2020 Perhaps it is time to have exposure to this economic powerhouse and its 1.4 billion population, says Morningstar's Peter Warnes.

10/11/2020 What happens when you buy something when your bank card? Morningstar analyst Niklas Kammer explains which companies are benefiting from your transaction.

09/11/2020 With travel bans and economic lockdowns, the luxury sector has been hit hard in 2020. But there are still opportunities, says Morningstar analyst Jelena Sokolova.

05/11/2020 A discussion of taxes, stimulus, regulation, and the likely market reaction as results from the 2020 poll come in.

03/11/2020 Why you should resist the urge to make predictions when there's a disconnect between the economy and security prices.

02/11/2020 Etoro analyst Josh Gilbert shares his thoughts on Beyond Meat and two other companies making inroads into the plant-based meat sector.

30/10/2020 The Magellan rainmaker explains why he doubts the Republican leader will prevail and why investors should brace for volatility—and ignore it.

29/10/2020 The market for plant-based meat is worth $14bn today and is expected to grow massively, says eToro's Josh Gilbert.

28/10/2020 Morningstar equity analyst Johannes Faul explores the flipside to the surge in growth in online sales.

22/10/2020 China and Hong Kong have been a happy hunting ground, says Longlead Capital Partners' co-founder Andrew West, who singles out tech, pharmaceuticals and power tools.

22/10/2020 These names stand to benefit from a resumption of leisure travel - and are all trading below our fair value estimates.

20/10/2020 Morningstar's Mark Preskett looks at three reasons why bonds are an important tool in your investment portfolio.

19/10/2020 A bigger stake in the online conveyancer PEXA could be the key to increasing Link Administration's revenue, says Morningstar's Gareth James.

16/10/2020 Longlead Capital Partners co-founder Andrew West reveals how his Asia-focused fund managed to make gains during the historic covid-19 sell-off.

16/10/2020 The investment board is back with an explainer on why you might invest in bonds.

13/10/2020 How to handle this decision—even when it is made for you.

12/10/2020 Nick Griffin of Munro Partners reveals why and where he sees opportunities in renewable energy, diagnostics and software.

09/10/2020 Take stock of your spending to determine if inflation is an issue for you.

09/10/2020 Morningstar analyst Chelsey Tam explains why investors are excited about the flotation of Ant Group and why it's different from Alibaba.

06/10/2020 Companies that address the growing demand for decarbonisation will have a 20-year growth opportunity, says Nick Griffin of Munro Partners.

30/09/2020 EXCLUSIVE EXTRACT: Morningstar's Mat Hodge and Lex Hall talk to the CEO of the independent producer and exporter about the company's fortunes and its future.

30/09/2020 Slow and steady wins the financial race.

29/09/2020 American Century Investments' low-turnover strategy invests in companies developing vaccines, treatments for neuro-cognitive diseases and innovations in telemedicine.

25/09/2020 By 2050, almost 20 per cent of the global population will be over 65 and demand for healthcare will climb, says Michael Li of American Century Investments.

22/09/2020 The destruction of an indigenous cave shelter was unforgiveable but there are other reasons why the iron ore heavyweight is overvalued.

21/09/2020 Morningstar equity analyst Kristoffer Inton on the outlook for the seven producers under coverage.

18/09/2020 Morningstar's Seth Goldstein singles out three undervalued stocks that span the entire electric vehicle supply chain.

18/09/2020 The bumps and bruises of election time may tempt you to shift your portfolio strategy.

17/09/2020 UK-based Premier Miton's Simon Evan-Cook says the tech rally of 2020 is reminiscent of the dotcom boom, but inflation could be a bigger threat.

16/09/2020 By 2025, the cost of batteries and manufacturing will fall and EV functionality will improve, says Morningstar's Seth Goldstein.

11/09/2020 Estimating the length of your retirement with personalized information will help you save the correct amount.

09/09/2020 Morningstar's Chelsey Tam reveals which stocks and sectors have shone—and which have underwhelmed.

28/08/2020 Products, services, what is what in the world of finance—and how to look out for yourself

24/08/2020 A raft of companies have cut their dividends this year, leaving income investors concerned. But Morningstar's Dan Lefkovitz says there are still plenty of options out there.

18/08/2020 DNR Capital's chief investment officer Jamie Nicol profiles some of the top ten holdings in his Australian Equities High Conviction fund.

17/08/2020 Morningstar's Brian Han explains why he has trimmed his fair value estimate for Australia's dominant telco and the future of its dividend payout.

14/08/2020 DNR Capital's Jamie Nicol reveals how his Australian Equities High Conviction fund finds quality businesses that will endure difficult conditions.

13/08/2020 Put your money to work if you're looking for financial freedom.

10/08/2020 Learn how to picture your goals so you can better reach them.

05/08/2020 Morningstar's Gareth James identifies three sector names trading at attractive discounts in an increasingly 'essential' sector.

05/08/2020 Reports of the strategy's demise are greatly exaggerated, says Morningstar's Christine Benz.

04/08/2020 Investors may assume a fund's yield to determine how much income it will pay, but it's not always so simple, warns Morningstar analyst Rajesh Yadav.

03/08/2020 It depends on your expectations and timeframe. Look at bonds as being portfolio stabilisers—sources of cash flow you can draw on when your equities are down, says Christine Benz.

28/07/2020 When utility stocks plunged during the onset of the pandemic Lazard Asset Management's Warryn Robertson knew it was time to jump in.

24/07/2020 Lazard Asset Management's Warryn Robertson looks at how the pandemic has affected toll roads and airports and what the future of travel holds.